5 Technical Setups to Trade in the Commodities - views

BALTIMORE (Stockpickr) -- It’s been a tough year for stocks. As I write, the S&P 500 and the Dow are barely breaking even in 2011 with just three trading sessions to go for the year. It should come as no surprise, then, that investors are paying more attention to commodities in this market.

More and more, retail investors are realizing that buying “the stock market” isn’t their only option to grow a portfolio. With asset classes ranging from fixed income and money markets to real estate and commodities, there are many alternatives to stocks out there that can offer equity-like returns with limited correlations to equity indices. Gold and oil provided one of the most salient examples of that fact back in 2007 when both commodities rallied dramatically as the floor was just starting to fall out from stocks.

With the growing popularity of exchange traded funds, it’s easier than ever to get exposure to scores of different commodity markets. With that in mind, we’ll take a look at promising tech setups forming in the most significant commodity markets right now.

For the unfamiliar, technical analysis is a way for investors to quantify qualitative factors, such as investor psychology, based on a stock's price action and trends. Once the domain of cloistered trading teams on Wall Street, technicals can help top traders make consistently profitable trades and can aid fundamental investors in better planning their stock execution.

By far, gold is the single commodity that’s been getting the most attention lately, thanks in large part to the fact that this metal acts more like a currency than a commodity under most market scenarios. The most popular way to trade gold is through the SPDR Gold Trust (GLD), a $66.1 billion ETF that owns gold held in trust in vaults under London.

While GLD may be a popular choice for getting exposure to gold, the metal has been struggling to hold recent prices in the latter half of 2011. That’s perplexed more than a few investors as the weakness of the euro and dollar make gold look like a comparably attractive “currency” right now.

Macro story aside, the technicals continue to look weak for gold. This metal has fallen through several key support levels since August, the most recently being $165 at the start of this month. Momentum, as measured by 14-day RSI, remains in a sustained downtrend. If you’re looking for a good opportunity to buy gold while it’s “cheap,” I’d strongly recommend waiting for this metal to find a more significant support level.

A test of $152.50 might be goldbugs’ next chance to buy GLD with limited risk.

We can’t talk about gold without mentioning silver, sometimes known as “high-beta gold”. Silver gets its nickname because this metal essentially tracks the price movements of gold, but with higher-volatility.

That’s not exactly the whole story. Unlike gold, silver has substantial industrial demand and unrecoverable use (in other words, the world’s supply of silver is reduced by its use in industrial processes). Perhaps more compelling, silver is trading at a historic discount to the price of gold. So what does this metal look like from a technical analysis standpoint?

Like gold, silver has been falling out of favor of late. Where GLD is down around 4% in the last three months, the iShares Silver Trust (SLV) is down 10.4%. But unlike its better-liked brother, silver is actually testing a significant support level right now at $28.

While SLV is slightly below $28 as I type, this metal’s ability to catch a bid somewhere around this longstanding support level would be a big signal to investors that it’s time to consider going long again. More risk averse investors would do well do wait until the downtrend line (currently around $30) gets broken.

Oil

In contrast to metals, oil has been having a terrific run over the past few months. Unlike precious metals, which typically rally when the economy is weak and investors want to diversify away form the dollar, oil prices are very driven by demand for crude. That means that they tend to have a positive correlation with stocks -- and they certainly have in the last quarter.

The United States Oil Fund (USO) is one of the most popular ways for retail investors to get exposure to crude oil prices. Right now, USO is testing a strong resistance level at $39.50. While the existence of a strong resistance level sound like a negative, it’s actually a positive. That’s because a breakout above that $39.50 level is that much more significant if we can identify that a glut of supply has previously cause it to act as resistance for shares.

The fact that USO’s formation is broadening is a mark against the trading implications of this setup (broadening support and resistance generally point to unruliness at best and bearishness at worst) -- but I’d suggest withholding judgment until it gets a bit further along. We could be in the early stages of an inverse head-and-shoulders setup in oil, after all.

Regardless, a breakout above $39.50 makes a strong buy signal. If and when it happens, I’d recommend keeping a protective stop just below the 200-day moving average.

Base Metals

Base metals, which include copper, steel, and aluminum, are a whole different animal from the silver and gold that we looked at; that’s a fact that’s immediately evident from one look at a chart. That’s because these metals are wholly driven by industrial demand and mining supply factors, not by flights-to-quality from stocks.

Even so, this group of hard commodities is showing strength right now. One of the most accessible ways to play the base metals is through the PowerShares DB Base Metals Fund (DBB), which invests in aluminum, copper and zinc futures. Techincally, DBB is showing traders an “if/then setup” right now, a trading setup whose direction is contingent on which way DBB breaks out of its sideways trading range.

Simply put, this fund’s if/then setup works like this: If shares break out above resistance (at $20.50), then buy. If shares break down below support (at $18), then DBB is a short candidate. Until one of those conditions gets met, I’d suggest sitting on the sidelines with this stock.

Agricultural Commodities

Finally, we’ve got the soft commodities – which can include everything from grains to corn, coffee, and cattle. These agricultural commodities are tracked by the PowerShares DB Agriculture Fund (DBA).

DBA has moved lower for much of 2011, dragged down by stabilizing food prices and a general capital flight away from risk assets and toward risk-free investments like treasuries. Now, though, it looks like DBA has bottomed, bouncing hard off of support at $27.50. Shares broke their downtrend line last week, and they’re looking to push through their next important resistance level at $29 this week. I’d recommend waiting for that $29 breakout to happen before buying.

Even though DBA has made lower lows in October and December, a very long-term failure swing in the fund’s 14-day RSI adds some confirmation that this latest bounce could have more legs than the one in October. When shares push above $29, I’d recommend keeping a protective stop just below DBA’s most recent swing low.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.